The sub-prime crisis claims its first scalp

As Edward Cahill returned from holiday it was clear he was on borrowed time. After three years at the cutting edge of Barclays' formidably successful capital markets division, the thrusting 33-year old financier realised his world had imploded. Cahill had devised exotic debt packages that, as global markets unwound in fear of a subprime credit crunch, had become virtually worthless.

Despite being described by some former colleagues as 'a bit of a lad', he was one of those dubbed 'rocket scientists', who had devised ever more elaborate ways to package debts - from bonds to mortgages, from loans that were super secure to those with white-knuckle risk levels.

Energetic Cahill had enjoyed the turbo-charged earnings that had seen former members of the Barclays Capital operation splash out £44,000 on dinner at Gordon Ramsay's London restaurant, Petrus.

Though Barclays declined to comment and colleagues described him as relatively junior, despite holding the grandiose title of head of European collateralised debt obligations, his departure raised fears that the goings on in Barclays Capital were not fully understood by the bank's powers that be.

Ever since Nick Leeson's bosses at Barings failed to grasp the magnitude of what their wayward employee had been up to, global financial markets have been terrified of a repeat whereby a financial wunderkind would run amok under their noses.

It is understood, however, that Barclays' compliance officers - its internal regulators - checked out Cahill's division and found nothing untoward.

But Cahill's current whereabouts are not known to the bank. He could not be contacted at his fashionable loft apartment near Barclays' Canary Wharf headquarters in east London. And though Cahill, an Irishman, set up a company in Dublin two years ago, helped with a loan from his employer, he could not be reached there either.

Barclays was already the focus of City attention, having been revealed as taking an emergency loan of £314m from the Bank of England. Such overnight loans are pretty routine, but in the current climate it was another excuse to hit the panic button. And as stock markets staged a half-hearted recovery last week, Barclays shares fell almost five per cent.

This is especially unfortunate as Barclays needs a strong share price to help in its £45bn takeover battle for Dutch bank ABN Amro. And as Bob Diamond, the fearsome American president of Barclays directly responsible for Cahill's division, tries to present a brave face at a golf tournament sponsored by the bank in New York State this weekend, the meltdown will be an unwelcome headache.

Yet, if it is all just a storm in a teacup, why have the goings on at Barclays caused such waves in the Square Mile? The answer is fear. Fear of a major crisis at a top bank. Fear of bankruptcies and job losses. And what is making it even worse is that no one knows where the crisis may emerge.

At the root of the panic are credit markets and the products in which Cahill specialised, known as collateralised debt obligations - a method of parcelling up loans and selling them on. Typically, these include a range of debt from bonds to mortgages, from low to high risk.

Other investors are then invited to buy a stake in the CDO vehicle, again with different stakes offering different levels of risk and return. Cahill's speciality - SIVlites, a variation of structured investment vehicles - were an even more exotic version that used short-term borrowing. But the squeeze on short-term credit has sent two SIVlite products into meltdown.

Few, other than those who design the products, really understand how they work. Those who favour CDOs insist they allow the risk of bad debt to be spread across the financial system, limiting the exposure of any one company. Critics, such as US investment guru Warren Buffett, have long warned that the complexity means no one really knows who is at risk.

Now there is a real economic problem hitting the CDO world - the US sub-prime mortgage market where home loans have been given to people with poor credit records. As the US housing market began to slump, these loans have turned bad, but because of the tangled web of CDOs no one is sure where the buck will stop.

This panic has been felt in stock markets worldwide. While the prospect of interest rate cuts by central banks has calmed nerves, the fear remains that the 'toxic waste' of bad debt will crop up when least expected. And the biggest UK player in the CDO market is Barclays Capital.

Barclays' success to date in the credit markets has made Diamond and his crew some of the City's bestpaid bankers. Diamond, 56, earned a salary and bonuses worth £22m last year. His businesses accounted for 45% of the group's £7bn profits last year.

So it is just possible that the willingness of City gossips to believe in crisis at Barclays is spurred by envy as much as genuine concern. Either way, there will be few helping hands if Diamond finally comes a cropper.

... and market gloom scuppers sale

Fears of a deal drought for the rest of the year are gripping the private equity market, with news that another planned sale has been pulled because of the crisis in the global debt markets.

Private equity firms Cognetas and Englefield Capital have dramatically cancelled the £400m plus sale of outsourcing business Global Solutions Limited only days before opening bids were expected.

Global Solutions, which runs Britain's GCHQ spy centre in Cheltenham, Gloucestershire, was formerly the part of Group 4 that covered prisons, schools and hospitals and was put on the market in June when Cognetas and Englefield hired investment bank UBS to find buyers.

But last week the continued market instability led the two private equity firms to pull the plug on the deal.

Nigel McConnell, managing partner for Cognetas, said: 'We didn't want to proceed. It's not a good environment to sell an asset as there is too much uncertainty.'

Cognetas will hold on to Global Solutions, which also runs Manchester Magistrates' Court, until 2009 as originally planned but more dramatically has decided it will not try to sell any of its other businesses until next year.

McConnell said he thought the negative environment could last until 2008 - considerably longer than many experts have so far predicted.

In a more benign environment Global Solutions, which operates in a niche growth market and has stable cashflows, would be expected to sell relatively easily.